-- John Kemp is a Reuters columnist. The views expressed are his own --
By John Kemp
LONDON, June 24 (Reuters) - Consolidation of the global mining industry is nearing its logical conclusion. For years, senior executives have predicted that the sector would in future be dominated by five or six large diversified companies.
The proposed "production joint venture" between BHP Billiton and Rio Tinto, and Xstrata's mooted "merger of equals" with Anglo American would, if consummated, make that a reality.
BHP, Rio and Anglo-Xstrata, together with a handful of other strategic players -- Brazil's Vale, Chile's Codelco, Russia's Norilsk Nickel and U.S. Freeport McMoran -- would dominate production and trading of bulk commodities (iron ore) as well as a host of other strategic materials (copper, ferro-alloys and platinum group metals).
For steelmakers, manufacturers and consumers, consolidation raises legitimate concerns about lessening competition and its impact on investment and pricing. Competition authorities in the European Union and elsewhere will subject the deals to intense scrutiny. The question is whether they can find legal grounds to block them.
SALAMI SLICING PROBLEM
Taken in isolation, none of the deals is objectionable, though the production joint venture between BHP and Rio comes close to the line and should be subject to especially close and ongoing surveillance. Regulators may struggle to find adequate legal grounds to block them. But the cumulative effect of a whole wave of consolidations is to make the industry significantly less competitive. The issue is the familiar one of "salami tactics", first used to describe stealth takeovers by totalitarian parties in central and eastern Europe and later popularised in the British political satire "Yes, Prime Minister". Fictional Prime Minister Jim Hacker's chief scientific adviser shows that his boss will never reach a point at which he is prepared to press the nuclear button if the Soviets take over western Europe in a series of piecemeal moves rather than launching one brazen frontal assault. (http://www.youtube.com/watch?v=IX_d_vMKswE) The salami problem explains why the accounting profession was able to consolidate into just five major partnerships, reduced to four by the collapse of Andersen. Most observers agree this degree of concentration is unhealthy (at least from a public policy perspective) because it means that many large companies have little or no scope to change their auditor. It is also now impossible to contemplate the failure of one of the remaining four firms.
But regulators found it impossible to object to any of the long series of mergers and takeovers that brought us to this point because each deal was not objectionable on its own, even if the cumulative result produced a sub-optimal outcome. There is a risk this will now be replicated in the mining sector with similar results.
CONSOLIDATION DANGERS
When asked to justify consolidation, mining leaders cite synergies in administration and operations; the need for diversification to ride out the business cycle; and the need to attain a minimum efficient scale to finance huge multi-decadal investment projects costing billions of dollars. Similar arguments were used during the wave of oil industry mergers in the late 1990s and early 2000s that produced BP-Amoco-Arco, Total-Fina-Elf, and Chevron-Texaco.
But it is not obvious that mergers and greater corporate scale have produced benefits for consumers in the form of greater willingness to undertake risky investments.
Both the oil industry and the major mining companies have been criticised precisely for the lack of investment and failure to raise output more quickly during the first part of this decade in response to rising prices. Larger scale has not increased the oil majors' appetite for higher risk and higher cost projects; instead the industry is locked in a stand off with sovereign states over the terms of access to low-risk, cheap oil reserves in the Middle East.
It is, of course, possible to argue that the oil industry would have invested even less over the past eight years if the mergers had not gone ahead, but that is a difficult counter-factual to sustain, and evidence is sparse.
Set against the purported benefits of industry consolidation are real risks for consumers. The best discussion of the dangers was set out by the Australian Competition and Consumer Commission (ACCC) in its preliminary "statement of issues" on BHP's proposed acquisition of Rio Tinto last year (http://graphics.thomsonreuters.com/ce-insight/ACCC-SOI.pdf).
The ACCC noted that just three suppliers (BHP, Rio and Vale) accounted for a high share of the global seaborne iron ore market, and raised a series of concerns:
* The threat of competition from rival producers emerging might be limited given high barriers to entry (including long lead times and significant sunk investments in associated rail, power and port infrastructure). As a result, the ACCC noted "it is uncertain whether the threat of new entry is an enduring and effective competitive constraint on large, low-cost incumbent suppliers".
* The merged firm "may have the incentive and ability to influence global supply and global prices" to the extent it could "profitably time future production and infrastructure capacity expansions so as to maintain a shortfall of supply".
* The ACCC asked market participants for further information on the extent to which alternative suppliers might be "influenced by the pricing and expansion decisions of the major iron ore" such as to follow their "price leadership" or be "deterred by announcements regarding capacity expansions".
In the end, following further submissions from BHP, the ACCC pronounced itself satisfied on each of these points. Nevertheless, the issues remain very real. In its own review, based on the same evidence, the European Commission appeared poised to reach the opposite conclusion and insist on disposals as a condition for permitting the merger to proceed, until BHP scrapped the deal.
POLICY FACES KEY SHOWDOWN
In recent years, competition regulators have often been prepared to tolerate much higher levels of industry concentration than in the past, relying on the theory of market "contestability" and the threat of potential entry rather than actual competition from existing rivals to exert discipline on prices.
But contestability is a piece of clever economic theory that has worked less well in practice. There are signs a re-examination is underway. The European Commission's decision to make the proposed BHP-Rio deal conditional upon structural remedies appeared to mark the limits of regulators' tolerance for these highly concentrative deals and the end of the "New Gilded Age" of permissive merger regulation.
The Obama administration's new antitrust chief, Christine Varney, also signalled a tougher approach in a high profile speech last month. She promised a "shift in philosophy" and to be aggressive in pursuing cases where monopolists try to use their dominance to stifle competition.
The proposed BHP-Rio production joint venture, and Xstrata's interest in Anglo American, pose a direct challenge to this new line.
The BHP-Rio tie up has been specifically structured as a production joint venture to escape scrutiny. Unlike full mergers, joint production arrangements are not normally called in for prior review; the two companies have promised that ore sales will be done separately and on a competitive basis. But since investment plans would have to be jointly agreed, it is hard to see how the tie up would not give rise to similar concerns.
Competition regulators need to step back and look at the aggregate effect of these deals on the shape of current and future competition, and what type of industry structure is an acceptable outcome at the end of the process.
The traditional case-by-case approach embodied in past precedents may make that difficult. In the medium term, more effective competition enforcement may need a change in the law to enable regulators to take a broader view. But in the meantime, they would be advised to adopt an expansive reading of their existing powers to subject this spate of mining deals to intensive scrutiny before it is too late.
(Edited by David Evans)